What does a great company look like?

What are the hallmarks of a great company? It’s a deceptively simple question, the answer to which is likely to depend on the investment strategy of the person it’s put to. Nevertheless, there are some things I think we, as Foolish investors, would all agree are desirable.

Defining ‘greatness’

The first quality investors should have on their list is a company’s ability to provide a product or service that its customers can’t do without or are willing to pay more for even if cheaper alternatives exist. For instance, the user-friendliness of its devices and sensitivity to offering consumers what they want has propelled Apple…

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What are the hallmarks of a great company? It’s a deceptively simple question, the answer to which is likely to depend on the investment strategy of the person it’s put to. Nevertheless, there are some things I think we, as Foolish investors, would all agree are desirable.

Defining ‘greatness’

The first quality investors should have on their list is a company’s ability to provide a product or service that its customers can’t do without or are willing to pay more for even if cheaper alternatives exist. For instance, the user-friendliness of its devices and sensitivity to offering consumers what they want has propelled Apple to the very top of the tree in terms of market capitalisation. Despite recently scoring something of an own goal through its very public spat with Tesco, Unilever would be another example thanks its massive portfolio of sticky brands that customers desire.

A second characteristic could be a company’s potential to grow to a very large size. Here, in-demand premium mixer producer, Fevertree would be a relevant case study. Since listing two years ago, shares have shot up by over 600% and, if analyst estimations prove accurate, there could be further upside left to come. This is why it can pay to look for opportunities further down the market spectrum. By recognising their potential early on, investors can make serious amounts of money.

Other things to look out for are companies that are able to achieve high operating margins and invest capital at a high rate of return. Those that can do so consistently should see earnings grow many times over which, in turn, should drive the share price higher. British engineer, Victrex ticks both of these boxes, in my opinion.

One final characteristic of a great company is its potential to endure for decades. This is one of the reasons why, in addition to chasing pharmaceuticals and utilities, many long-term investors have piled their cash into Sirius Minerals. Since its planned polyhalite mine in North Yorkshire will have an estimated life of 100 years, this could be one share that keeps on giving.

Does price matter?

At this point, however, we encounter a problem. Even when they do find a company that satisfies all of the points above, some investors may be disinclined to snap up the shares because they’re seen as ‘expensive’ on traditional measures. They might argue that Fevertree’s price-to-earnings (P/E) ratio of around 50 or even Unilever’s P/E of 20 are just too high.

I think this is a mistake. As Warren Buffett said: “It’s better to buy a wonderful company at a fair price than a fair company at a wonderful price.” In other words, basing investment decisions more on the price we’re being asked to pay and less on the quality of the company is dangerous, particularly as many businesses trade on temptingly cheap valuations for a reason.

What’s more essential, in my view, is recognising the fact that a great company can become distinctly average over a relatively short time if the story changes. This is why investors need to keep an ear out for any stock-specific news relating to companies they own and resist falling in love with a particular share. If the reasons for investing no longer apply, it’s time to move on.

Searching for quality?

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Paul Summers has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Unilever. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.